Do discount rates make sense in a finite universe?
Finance professionals regularly calculate the expected value of a future stream of cash flows and then discount those back to the present. You've got the explicit forecast for a certain number of years, and then the perpetuity growth rate after that. The discount rate reflects the pace at which your money will compound, and the perpetuity growth rate reflects the growth in the asset itself. Neither of these rates seems to be justified in a finite universe with a fixed amount of stuff.
For risky investments, discount rates are regularly greater than 20%. Discount rates this high seem to be at odds with a universe that always has a fixed amount of mass. How do discount rates like this make sense over even a hundred years, to say nothing of thousands?
Is the answer to accept that high discount rates make no sense, but we choose to use them to justify amassing enormous wealth in our short lifespans? Although this is a perfectly acceptable answer, I worry that people are deluding themselves into believing that perpetual growth makes sense in a fixed universe. Perhaps I'm wrong in thinking this way, and someone here has some resolution to this.
Risky investments can gain you 20% but you can also lose 20+%.
Having considered this view, I don't know if it's tenable. Certainly, Masayoshi Son does an excellent job of losing amounts like that and even more, but most investors don't. LBO firms and other investors have tended to control more assets as time goes on. Financial investors have continued to amass control over more and more resources. The question is whether it's appropriate to believe in this perpetual growth where arguably none exists.
Stoned posting on WSO certainly yields dividends
You made my day. The line between stonerdom and philosophy is vanishingly small.
The finite nature of the universe doesn’t matter—there are enough dollars in existence that, to the individual, their number could practically be called infinity. The TVM model essentially reduces the size of the universe to one person and his/her investment as well as a party who will always either pay a risk-proportionate amount of interest or demand a risk-proportionate payment. Thus, as long as there is money to pay interest ad hoc, the universe can be considered infinite for all intents and purposes.
One of your propositions appears to be this: "the universe will not run out of resource claims for people in the next, say, 120 years (roughly the maximum human lifespan)." I think most people would agree with you there. Perhaps certain things are in short supply, but with concepts like space colonization or asteroid mining, humans as an aggregate could likely continue acquiring assets for themselves.
But that doesn't negate what I said: that over millennia and periods beyond that, it's absurd that investors can consistently control 20% more stuff than they did the previous year, much less other numbers.
I agree, but we have to also understand that many investors are getting negative returns or even losing their entire investment, so if the entire human race gains an aggregate of 2% per year on average that would not be an unreasonable rate of growth of monetary supply. Part of this explains the rate of inflation.
I might be getting a little philosophical, but why do you think that the universe is finite?
There's a finite number of assets in the universe under human control. Even with our space probes, they've traversed a small fraction of what's out there. Besides that, how much dominion can we exert over space anyway? Overall, the percentage growth in resources humans can access is almost assured to be less than any investor's discount rate.
Plenty of scientists believe that dark energy continues to increase the mass of the universe. Dark energy could appear to justify the infinite growth narrative, but can we make use of stuff like that? It's probably not knowable in my lifetime.
Exponential, hyperbolic, quasi-geometric, and quasi-hyperbolic discounting functions are just models used to interpret the world to our current understanding in economics, consumption behavior, and finance.
Think about how much science has advanced in the last 300 years. Eventually financial models will get better and better over time, for now discounted cashflow is just the best solution humans have come up with. Maybe you can come up with a better model of the real value of a particular asset or business strategy; if you are successful there is a lot of money to be made if you know the real future value of any asset.
I agree with you that our methods of calculating the expected value of an annuity stream will change and arguably improve in the future. My question is about the human race continually expecting control of more and more assets over time.
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